After a slow start, last week turned out to be pretty solid for the USD as the unit was steady or stronger against all the G-7 pairs. Even though the mid-week economic reports on manufacturing were on the weak side and the US service sector expanded at the slowest pace in 6 years, Treasury yields moved higher supporting the USD’s rally. The US 10-year yield was up 16 basis points from the mid-week low of 1.50% and reached its highest level since the UK referendum in late June.
However, US equity markets were beaten down after Boston FED President Eric Rosengren said there was a “reasonable case” for a rate hike at next week’s FOMC meeting. These comments pushed the SP 500 just below 2120 and, from a technical perspective, sets up a very ugly chart pattern. The Relative Strength Index (RSI) dropped from 54.2 to 31.00 and the MACDs have rolled over on the daily charts.
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It’s worth noting that this is just one day and the major equity indexes may reverse course in short order, but it’s a reminder of how vicious the market decline was in January following the FOMC’s initial rate normalization from the zero bound.
Ahead of the media blackout period in front of next week’s FOMC meeting, FED Governor Lael Brainard will speak on Monday at an economic conference in Chicago. Ms Brainard has generally been in the dovish camp, and has tended to emphasize the international risks of FED policy trajectory. Her speech, on the outlook of the US economy, will be closely watched by market participants.
In this sense, if there’s no change in her core position or tone, it would lend support to equities, lower yields and lead to a softer USD. One the other side of the coin, any hint that the FED has been sufficiently cautious and that the normalization objectives have been met could lead to an extension of Friday’s price activity.
This type of diametrical “cause and effect” price prognosis is the ugly underbelly of the markets that the central bankers have created, and is what they fear the most. On balance, we maintain the view that the Fed Funds futures market has underestimated the possibility that the FED will lift the Fed Funds target band to .50% – .75% next week, and short-term traders have overestimated the resultant equity market impact within the broader bull market pattern.
